The market for corporate control

Question 1

Describe what a friendly takeover is.

Answer 1

If target board and shareholders are willing to accept premium offered, or exchange ratio for stake in the combined firm- deal is accepted.

Question 2

When does a bidder initiate a hostile takeover?

Answer 2

If target board and shareholders find premium too low, and don’t want to relinquish control they advisde the CEO to reject the offer.

Once this happens that bidder can start a more aggressive attempt and initiate a hostile takeover.

Question 3

Describe and explain some takeover tactics:
Bear hug
Proxy fight
Open market pressure
tender offer
Litigation

Answer 3

Bear hug- Offer made to target shareholders to buy at a significant premium.

If this fails:
Proxy fight- where groups of target shareholders group together to win the vote.

Open market pressure- Bidder starts buying target shares on the open market.

Tender offer- Public invitation to target shareholders to sell their shares within a window

Litigation- Target initiates legal proceedings to delay takeover and/ or raise costs.

Question 4

What are some key characteristics and motivations of hostile takeovers?

Answer 4

They tend to be more costly, (Legal fees, proxy battles, financial advice), often requiring increase in offer price / premium bids to secure target shareholders.

A common motivation is identification of entrenched or indifferent top management teams, usually the CEO. The belief is that the active CEO is sub-optimally utilising assets ad potential of the company management.

Potential for synergies- Cost savings, enhanced market power or improved resource allocation.

Question 5

Describe the effect hostile takeovers have on the market for corporate control.

Answer 5

Acts as a disciplinary role- Hostile bids serve as a check on management inefficiency. When a management team fails to maximise shareholder value, external parties can intervene by attempting to take control of the firm.

Allocation of resources: Hostile takeovers promote the efficient allocation of resources by transferring control of assets to entities that can utilise them more effectively.

Question 6

Explain some economic implications of hostile takeovers.

Answer 6

Short-term gain for shareholders- Target shareholders typically benefit from higher share prices due to the premium offered by the acquirer.

The long-term impact for both firms value, depends on the acquirers ability to realise projected synergies and improve the targets performance.

Disruption to communities and employees- Hostile takeovers often lead to significant restructuring, including layoffs and operational changes. This can negatively impact employees, local communities and suppliers.

Potential for overpayment- when hostile bods escalate into bidding wars, overpayment can result in negative NPV for the acquirers shareholders.

Defence mechanisms and inefficiencies- To defend against hostile takeovers, target firms may adopt costly defence mechanisms, which can increase transaction costs and create inefficiencies in the market for corporate control.

Question 7

What is the market for corporate control?

Answer 7

The arena in which firms are bought and sold.

It plays a critical role in ensuring that companies are efficiently managed and that corporate resources are utilised to maximise shareholder value.

Question 8

Describe what separation of ownership and control is.

Answer 8

An organisation where the functions of decision making and bearing and distinctly separated.

Question 9

Describe control in the separation of ownership and control in a firm.

Answer 9

It refers to the activity over corporate resources and key strategic resources.

This function if carried out my managers (particularly CEO), who are appointed by shareholder.

Managers are expected to act in the best interest of shareholders by maximising firm value.

Question 10

Describe ownership in the separation of ownership and control in a firm.

Answer 10

Refers to bearing the financial consequences of the firms operations and decisions.

Shareholders, as the owners, bear this risk because they can provide capital and expect a return on their investment through dividends or capital gains.

Question 11

Describe the difference between residual claims vs fixed payments in a firm.

Answer 11

CEOs receive a salary (fixed payments) while shareholders have residua claims on value of firm (equity).

Shareholders wealth bears the risk for decisions made by CEOs, while CEOs are relatively insulated- they receive contractually agreed remuneration ether way.

Question 12

Explain how the separation of ownership and management can lead to agency problems.

Answer 12

Agents (CEOs) are not deincentivised from taking risks to activate greater firm value.

CEOs might act to maximise their wealth of instead of shareholders.

And identification of CEOs not acting in shareholders best interest can lead to firm value being lower than expected.
This can trigger a form of discipline, where other firms make a takeover bis to replace incumbent CEO and make better use of the targets assets.

Question 13

How can ‘bad bidders’ be seen as good targets for firms?

Answer 13

A failed or bad acquisition signals poor management decision-making and suboptimal use of corporate resource, which can decrease the firms value.

Once this happens, it becomes a more attractive takeover target for other firms.

Question 14

What are some examples of why a firm would be seen to be a bad bidder?

Answer 14

Overpaying
Integration issues
managerial hubris- CEO personal ambition rather than SH value.
Misjudged strategic fit.

Question 15

Explain how the separation of ownership and management can create tension between the shareholders and CEO in relation to risk taking.

Answer 15

Shareholders typically prefer some level of risk to maximise returns, as higher risk profile can lead to greater long-term value.

Managers (CEOs), on the other hand, may be more risk averse, concerned about job security, personal reputation, and short-term performance, which can discourage them from taking value-enhancing risks.

However takeover defences provide CEOs with a buffer fro immediate market pressures, allowing them to pursue strategic decisions without constant fear of losing control of the company.

Question 16

What are the three types of takeover defence?

Answer 16

Proactive defences

Deal-embedded defences

Reactive defences

Question 17

What are proactive defences?

Answer 17

Put in place in response to a general concern about a potential takeover attempt e.g. poison pill, staggered board, golden parachute.

Question 18

What are Deal-embedded defences?

Answer 18

Features of definitive agreements and are intended to raise the ante for an intruder (against interference)

Question 19

What are reactive defences?

Answer 19

Respond directly to the identity of the hostile bidder/ and the characteristics of the hostile bid. Aimed at repelling known specific bidders.

Question 20

What are Anti-takeover Provisions (ATPs)?

Answer 20

Mechanisms embedded in corporate governance to deter hostile takeover defences.

Question 21

What are the 3 main reasons why ATPs exist?

Answer 21

Maximising shareholder value: ATPs give the target firms board and management time flexibility to negotiate better terms or seek alternatives buyers, thereby ensuring shareholders receive maximum value in the event of a takeover.

Job security and Long-term strategy- Without ATPs, managers may focus excessively on short-term performance to deter takeovers, potentially sacrificing long-term investments and strategic goals. By providing a buffer against immediate takeover threats, ATPs allow managers to pursue long-term value creation.

Discourage nuisance- some takeover bids are speculative or opportunistic aimed at acquiring undervalued firms cheaply. ATPs make such bids expensive and complex, discouraging low-effort of speculative bidders.

Question 22

Explain what a risk-return framework is and how a decision about a takeover can be made from it.

Answer 22

This framework allows bidder to evaluates wether the expected payoff is positive:

p * ( intrinsic value- price paid - transaction costs) - (1-P) * transaction cost > 0

p= probability of a successful takeover.

The bidder should attack if the expected payoff is positive.

Question 23

Proactive ATPs: List all of the charter agreements:

Answer 23

Classified (staggered) board

Supermajority provision

Fair price provision

Dual-class recapitalisation

Question 24

Proactive ATPs: What are charter amendments?

Answer 24

Changes to a firms governing documents to make hostile takeovers more difficult. These provisions reduce the likelihood of a hostile bidder successfully gaining control of the target by raising procedural hurdles.

Question 25

Proactive ATPs: Classified (staggered) board.

Answer 25

Classified boards are elected fractionally each year. This amendment, rather than where all directors are elected annually, delays the bidders ability to control the board.

Question 26

Proactive ATPs: Supermajority provision

Answer 26

Mergers must be approved by an extra-large majority of votes. This ensures that even if the bidder gains a controlling interest, they may struggle to secure enough votes for approval.

Question 27

Proactive ATPs: Fair price provision

Answer 27

Requires that all selling shareholders receive same price form the buyer. This prevents discriminating offers from the bidders, where a bidder my offer a premium to a controlling block of shares and a lower price to the remaining majority.

Question 28

Proactive ATPs: Dual-class recapitalisation

Answer 28

Involves issuing 2 classes of shares with different voting rights. This allows the existing controlling shareholders or management to retain control, even if they own a minority of the total equity. Bidders will find it difficult to gain voting control, making a hostile bid unattractive.

Question 29

Proactive ATPs: Explain some other charter amendments

Answer 29

Limit the ability of dissident shareholders to call special meetings or require the board to consider non-financial factors (e.g. employee welfare, community impact) in evaluating takeover bids. These create additional legal and procedural obstacles for hostile bidders, slowing down or deterring the takeover process.

Question 30

Proactive ATPs: Golden parachutes

Answer 30

They grant generous severance packages to key executives if they are dismissed following a change in control. Bidders could be deterred by the additional cost. However, managers may be less concerned by personal job loss and ore focused on securing the best price for shareholders.

Question 31

Proactive ATPs: Employee share ownership plans (EPOPs)

Answer 31

Setting up a trust that borrows money to purchase a firms shares on behalf of the employees. The ESOP becomes a large block holder, often loyal to current management, making it harder for hostile bidders to acquire a controlling stake. Employees are likely to vote against a takeover if they fear job losses, reducing the probability of success for the bidder.

Question 32

What are Poison pills?

Answer 32

Give existing shareholders the right to purchase additional shares at a nominal cost upon triggering event.

Question 33

List the types of poison pills.

Answer 33

Flip in provision Flip-over provision Poison pots

Question 34

Proactive ATPs: Flip in provision

Answer 34

Give the existing shareholder the right to purchase additional shares in the target firm at a significant discount once a hostile bidder crosses a threshold. This dilutes the bidders stake, making it more expensive to acquire additional shares and reducing their voting power.

Question 35

Proactive ATPs: Flip over provision

Answer 35

Allows existing shareholders to buy shares in the target firm at a significant discount if the hostile bidder merger with the target. This makes the acquisition unattractive by diluting the bidders own equity in the combined firm, lowering post-merger share value.

Question 36

Proactive ATPs: Poison pots

Answer 36

Trigger debt repayment at or above par value in the event of a change in control. This deters bids by forcing the bidder to arrange more financing and possibly to pay a premium for the targets bets.

Question 37

Reactive ATPs: Litigation

Answer 37

Involves initiating leal proceedings against the bidder to delay the acquisition (Anti-trust regulations or securities laws). Increased transaction costs for bidder, delay takeover, high uncertainty.

Question 38

Reactive ATPs: Regulatory and/or legislative protection

Answer 38

Governments can intervene by enhancing laws or regulations that protect the target firm from a hostile takeover. Gov intervention acts as an external shield, raising the legal and compliance burden on bidders. Increased complexity- Bidders must navigate regulatory hurdles, adding to the time and cost of the takeover.

Question 39

Reactive ATPs: Counter-tender offer (Pac-Man defence)

Answer 39

The target firm launches its own bid to acquire the hostile bidder. The target attempts to acquire shares of the bidder, effectively turning the tables on the hostile bidder. Leads to a costly standoff between the 2 firms. Leverage in negotiation- Even if the target doesn't complete the acquisition, the threat of a counter-bid can compel the hostile bidder to withdraw of negotiate a higher bid.

Question 40

Reactive ATPs: Leveraged recapitalisation

Answer 40

The target firm borrows heavily and uses the funds to pay a large one-time dividend to shareholders to pay shares. This results in a highly leveraged firm with increased financial risk. This strategy raises expected returns on equity but also increases the financial burden on the bidder, who would inherit the targets debt if the takeover succeeds. The target increased leverage raises its risk profile, making it less attractive to the bidder. A large dividend or share repurchase can boost the stock price, forcing the bidder to offer a higher premium.

Question 41

Reactive ATPs: Share repurchase

Answer 41

The target firm buys back its own shares to reduce the number of shares on the open market. By repurchasing these shares, the target raises its equity and consolidates ownership. This reduce the budders ability to acquire a controlling interest in the target. leads to an increased cost for the bidder.

Question 42

Reactive ATPs: Asset restructuring (crown jewel defence)

Answer 42

The target firm can sell or spin off key assets that the bidder was aiming to acquire. The firm may dispose of undervalued assets e.g. unused land, patent or spin off profitable subsidiaries. It can use the proceeds to fund a special dividend or share repurchase. Effect: Loss of strategic value- By selling off assets, the target reduced its attractiveness to the bidder. Increased cash holdings- Monetising assets provided cash that can be distributed to shareholders, raising the stock price and forcing a higher bid.

Question 43

Reactive ATPs: White knight and white squire

Answer 43

The target firm seeks a friendly buyer (white knight) or a large passive investor (white squire) to thwart the hostile bid. White Knight- A friendly firm agrees to acquire the target on favourable terms and typically commits to not to break up the firm or lay off employees. White squire- A friendly investor purchases a large block of shares, but does not seek control. The investor agrees to support the target management and prevent the hostile bidder from acquiring a controlling stake. The WK or WS dilutes the bidders ability to gain control The target can negotiate better terms with the WK, often securing a higher premium for shareholders.

Question 44

Reactive ATPs: Going private transaction/ leverage buyout (LBO)

Answer 44

The targets management or a private equity firm acquires the company and takes it private, often using significant debt financing. The management team, with the help of private equity, arrange financing to but out existing shareholders and delist the company. the resulting private firm is typically highly leveraged. This eliminated public float- Since the company is taken private, the hostile bidder can no longer acquire shares on the open market. The high levels of debt makes it unattractive for bidders to pursue the target.

Question 45

Reactive ATPs: greenmail or targeted share repurchase

Answer 45

Involves the target firm buying back shares from the hostile bidder at a premium, effectively paying the bidder to banden the takeover attempt. This is very costly to the target, however they retain control. Greenmail may also deter future hostile bidder by signalling that the target is willing to pay to avoid a takeover.